How I Decided Between an FHA and Conventional Mortgage

When my husband and I decided to move from Denver to Indianapolis to buy a house, we knew the process would be humbling. The only things we knew about the home-buying process came from watching HGTV or talking to friends and family who had done it before. We decided to jump into it with an open mind and a cautious approach.

The first major decision we faced was deciding which type of mortgage was best for us: Federal Housing Administration (FHA) or conventional. We had a general idea of what made these loans different, but it took some deep digging to figure out which option best fit our needs right now and for the term of our loan. Here’s how we made our decision:

First, let’s lay out the difference between the two types of loans: An FHA loan is a mortgage that’s backed by the federal government and serviced by a third-party lender. Basically, this means that the government will pay the lender if you end up not being able to pay—but you will still face foreclosure if you default on your loan. Because of this backing, lenders are a little more lenient about giving out loans, meaning that they’ll accept lower credit scores (FHA Loans have a minimum credit score of 500, while conventional loans usually require scores in the 600s) and down payments (the standard is 3.5 percent).

FHA loans also always require a mortgage insurance premium (MIP), which is a fee tacked onto your mortgage that you pay for the entire length of the loan. Your MIP varies between 0.45 and 1.05 percent of your mortgage value—depending on how much you borrowed, your loan-to-value ratio, and your loan term. There are only two ways to get rid of MIP: The first is eventually refinancing the loan to a conventional loan. The second is putting 10 percent down at the start, which allows you to ditch MIP after 11 years of payments. You’ll also pay a one-time insurance payment of 1.75 percent of the loan at closing. Because of all of these added fees over the value of the loan, FHA loans can end up being more expensive than conventional loans—even though in some scenarios, FHA loans have lower rates than conventional loans. In general, FHA loans tend to have more baggage attached to them—even though they’re easier to get in the outset.

But what are conventional loans, anyways? Also known as a conforming loan, these are mortgages that are not backed by the government. Because of this, lenders try and reduce their risk of the borrower defaulting as much as possible—something that you will pay for. That means that conventional loans usually have slightly higher interest rates and more rigid approval requirements than FHA loans. Though some lenders will accept as little as 3 percent down—anything under 20 percent will require you to pay private mortgage insurance (PMI). This monthly fee is required until you reach 78 percent equity in your home, but it usually doesn’t fall off your monthly payment until you hit 80 percent.

Our main concern in choosing between the mortgages was that we didn’t want to spend more money than we had to per month—even if the difference was small. Tiny fees and expenses add up over time, and with all the new expenses we were facing—repairs, furniture, painting, etc.—we needed to keep our budget as tight as possible.

According to our mortgage broker, we would end up paying $30 a month more with an FHA loan compared to a conventional loan. Our broker estimated we’d also pay $10,000 in tiny fees and expenses over the length of the loan.

If we went with an FHA loan, we’d also have to eventually refinance just to drop the MIP. Right now, rates are low and only rising, so it seemed if we refinanced we might not be able to get the low rates we have now.

Every mortgage expert I talked to said that we should go with conventional if we could get approved and afford it—and we could, so we did.

However, for homeowners who don’t have the money upfront or great credit scores, FHA loans are a good option because they accept the smallest down payment possible. On a $200,000 home, the minimum FHA loan down payment of 3.5 percent would be $7,000. For a conventional loan with 5 percent down, that would be $10,000. That $3,000 difference of cash up front can be a dealbreaker if you’re moving out of state, buying new furniture, or planning a home renovation.

And if you live in a high cost-of-living city where real estate goes quickly, you might decide it’s better to buy now with an FHA loan instead of waiting until you have enough saved for a conventional loan.

But this decision shouldn’t be yours alone—you should check in with a mortgage expert (like a loan officer or a mortgage broker) to make sure the mortgage you undertake fits both your short- and long-term goals.